Interim
Joint Committee on Appropriations and Revenue

Minutes
of the 2nd Meeting

of the 2003 Session Break

January
21, 2003

The 2nd meeting of the Interim
Joint Committee on Appropriations and Revenue was held on Tuesday,
January 21, 2003, at 10:00 a.m., in Room 149 of the Capitol Annex. Senator Richard
Sanders, Jr., Chair, called the meeting to order, and the secretary called the
roll.

Chairman Sanders opened the meeting and recognized Dr. Merl
Hackbart and Dr. Larry Lynch for their presentation of the FY 2003-2004 revenue
estimates made by the Consensus Forecasting Group.

Dr. Lynch reported that the Consensus Forecasting Group met
three times in November to revise its original estimates for the 2003-2004
biennium. Additional adjustments were made at a meeting held on January 17,
2003.

Chairman Sanders asked for an explanation of the process the
Consensus Forecasting Group uses to develop revenue estimates. Dr. Lynch said
the group consists of nine members from the Executive Branch, the Legislative
Branch, other state agencies, and the universities. The group meets
periodically throughout the year to review the national economy and Kentucky's
economic trends. A preliminary forecast is done in October, prior to the next
biennium, and an official forecast is completed by late December, or early
January, at the beginning of the biennium, which is the official forecast used
to prepare the budget.

Chairman Sanders asked what mechanism is used to officially
call the group into action. Dr. Hackbart responded that statute requires the
group to make two official forecasts, and any necessary revisions, on the call
of the State Budget Director.

Dr. Lynch said the national economy is experiencing a slow
recovery. There are a number of uncertainties clouding the economic picture for
2003, including potential tax cuts, a weakening dollar, and possible war with
Iraq. If the economy begins to strengthen in 2003, interest rates will probably
rise. Other considerations include a weakening in consumer confidence and a
possible increase in federal spending on military and homeland security.

Dr. Lynch said the Consensus Forecasting Group utilizes the
Global Insight firm for national economic forecasts. Global Insight's forecast
is assumes a short, successful war with Iraq, that the President's tax cut
package will be enacted, that federal expenditures will rise, stimulating the
economy by approximately $50 billion, and that there will be slow growth in the
Japanese and European markets, which could have a negative impact on Kentucky,
because of a greater ability to export. Between November 2002 and January 2003,
the real GDP estimate for fiscal year 2004 has been revised up with an
inflation rate near zero.

Dr. Hackbart said the economic outlook has not changed
dramatically since November 2002, when the Consensus Forecasting Group revised
its estimates. December retail sales were relatively weak, which paralleled the
national experience, resulting in a lower sales tax revenue estimate. In
addition, a number of unanticipated events occurred, most of which were
positive. There was a very large PowerBall jackpot, which increased lottery
proceeds by $10 million; an increase of the Tax Amnesty estimate by about $5
million; an increase in inheritance tax receipts, and an increase in both
individual and corporate declarations. Compared to last January, corporate
declarations were up $22 million and individual declarations were up about $30
million.

Chairman Sanders asked about the differences between the
forecast made in January 2002 and the January 2003 forecast. Dr. Hackbart said
there was a decline of about $169 million between the January 2002 forecast and
the November 2002 forecast. Since the November 2002 forecast, there has been an
adjustment upward of $94 million due to some unanticipated, one-time money, for
a net effect of a reduction of approximately $75 million compared to January
2002. On a percentage basis, General Fund growth is about 4.6 percent.

Senator Kelly said the forecast shows more growth in
Kentucky for 2003 than what was experienced nationally, but very little
improvement in 2004. He asked if the revisions are basically just adjustments
made to recognize January updates. Dr. Hackbart responded that they were. Dr.
Lynch noted that Kentucky's economic mix is another factor because Kentucky's
economy depends on manufacturing and the manufacturing sector is very weak
right now.

Senator Kelly said the sales and use tax and corporate and
individual income taxes have been quite volatile historically. He asked if the
forecast is projecting the January corporate and individual declarations in
2004. Dr. Hackbart responded that they were. He said the forecast is assuming that
higher declarations in corporate and individual income is an indicator of
economic health of corporations reflecting their perspective on their profit
position.

Representative Napier said his retail sales were up during
December. He asked how the forecasting group determined that December retail
sales are down when the sales and use tax receipts for December have not been
finalized. Dr. Hackbart said the estimate is based on November sales receipts,
which is a major indicator for Christmas retail sales. The estimate also uses
national estimates and unless Kentucky surpassed the national trend, December
is not likely to be very strong.

Dr. Hackbart said the overall revenue picture for 2004 has
not changed significantly, with an addition of only $5 million in revenue. The
revenue picture for 2003 has gone from an expected decline of $169.7 million in
November 2002, to an expected decline today of $75.4 million.

Senator Kelly said school systems were informed that they
were going to have a reduction in the amount of funds they will receive from
SEEK based on a $169 million reduction for 2003, and $186 million for 2004. Dr.
Hackbart said the revenue picture for 2003 improved due to some unanticipated
revenues.

Dr. Hackbart said the forecast for the Road Fund has
increased $9 million for 2003, and $2.9 million for 2004. Both are relatively
insignificant given the $1.1 billion revenue estimate.

Representative Clark said he thought there was a combined
shortfall of $509 million for 2003 and 2004, but the figures provided today
only indicate a $256 million shortfall. Dr. Hackbart said the estimates involve
two issues: revenue and expenditures. He said Ms. Lassiter will speak to the
expenditure side.

Senator Kelly asked if the Consensus Forecasting Group has been
briefed on proposed tax changes on business and industry that the Governor
outlined in a recent speech. Dr. Lynch responded that the group has not been
briefed.

Senator Kelly asked what impact a new tax structure would
have on businesses planning to expand, or locate in Kentucky. Dr. Lynch said it
would be difficult to determine the impact. He said new tax programs do make it
more difficult to forecast revenue.

Chairman Sanders called for a motion to approve the minutes.
Upon the motion of Senator Pendleton, and seconded by Representative McKee, the
motion passed.

Chairman Moberly said the revised forecast is very good news
for fiscal year 2003, even though the positive news is the result of some
one-time occurrences. He said, however, that he is concerned that the revenue
base for 2003 might be artificially high. Dr. Lynch said the 2003 one-time
money is not included in the base for the 2004 estimate.

Representative Cherry said corporate taxes have been on the
decline and now account for only one-half of what they did a decade ago. Dr.
Lynch said that is correct, but a decline in one tax also depends on what has
been happening to other kinds of taxes.

Senator Kelly said the shift in the level of corporate
income is the result of a change in LLC law, which caused a lot of corporations
to shift to an LLC form of business. He said it would appear that the revenue
stream has simply shifted from the corporate income tax to the individual
income tax because there has been a 28 percent growth in individual income
taxes in that same time period. He said the state is still collecting the same
level of income on business activity, it is just in a different category. Dr.
Lynch said corporate license and income taxes were $400 million in FY 1991,
$325 million in FY 2002. He said it is unknown how much has been picked up in
individual taxes. Dr. Hackbart said for forecasting purposes, the corporate
income and license tax are rolled together.

Representative Damron said he had questioned whether there
might be a shift from corporate to individual some time ago but the data is
evidently difficult to extract. He said the actual loss may be from the
corporate license fee, which is probably a fairly small amount in the total
scheme.

Representative Damron asked about the process the Consensus
Forecasting Group uses to reconcile the views of its nine members. Dr. Lynch
said that he and some of the other members generate their own numbers, and
staff also generates numbers. Each member has an area of expertise, and by
discussing and polling all members, a figure agreeable to all is determined.

Representative Damron asked how the group deals with a
variance between high and low estimates. Dr. Lynch said the group discusses and
selects the national estimates that are most agreeable to all members at its
first meeting; at the second meeting, the group discusses whether the agreed
upon figures are appropriate for Kentucky; and at the third meeting, members
discuss specific taxes, their impact, and their performance to date. There is a
lot of dialogue and the final process is where the differences are resolved,
arriving at complete consensus on the forecast.

Representative Damron said a one percent, or two percent
difference between a high estimate and a low estimate could have significant
implications on the budget process. Dr. Hackbart said the Consensus Forecasting
Group is required to provide a point-estimate.

Chairman Moberly noted that LLCs are being used by some of
the larger corporations operating in Kentucky, particularly multi-state
corporations, as part of their planning for tax avoidance. These large
corporations, which include Ashland Marathon Refinery, Kroger, Speedway, and a
large hospital chain, are not only getting a break on the corporate license
tax, they are also getting a break because their income tax is based on a one
factor (sales) basis rather than the three factor basis (sales, property, and
payroll) used for corporations, which is a particular advantage to out-of-state
corporations that do business in Kentucky. Chairman Moberly said the practice
is legal, but it was not the intent of the General Assembly to exempt large
corporations from paying their fair share of taxes. He said the Governor's
proposal is to continue to exempt the professional LLC, for which the law was
originally created, and corporations subject to the tax will be granted a tax
deduction on their individual income tax.

Chairman Sanders said Tennessee recently voted in favor of a
state lottery. He asked if the loss of revenue from Tennessee has been figured
into the forecast. Dr. Hackbart responded that it has.

Senator Westwood asked if there is historical data on
overestimating and underestimating the forecast. Dr. Hackbart said he could
provide that information. He said it does vary significantly because after the
1991-92 recession, the economy grew very positively throughout the 90s.

Senator McGaha asked if the Consensus Forecasting Group has
its own staff to prepare data. Dr. Hackbart responded that there is no devoted
staff. He said some members prepare their own data, but the group also draws
assistance from the Governor's Office for Economic Analysis and the Revenue
Cabinet.

Ms. Ginny Wilson, LRC Deputy Director for Research and
Finance, introduced Tom Hewlett, Legislative Analyst for LRC's Program Review
and Investigations Committee, and Michael Meeks, LRC Committee Staff
Administrator for Government Contract Review Committee. Ms. Wilson said in
September 2000, the Program Review and Investigations Committee authorized a
study to examine contracting for services in the Executive Branch. The
committee adopted the report conclusions and all recommendations on October 11,
2001.

Mr. Hewlett said members of the Program Review and
Investigations Committee approve the topics and objectives for all reviews
undertaken by committee staff. For this review, staff was asked to examine the
state's system of acquiring services by contract with particular emphasis on
the volume and nature of personal service contract use; the process for
awarding service contracts; the role of service contracts in overall use of
labor; and how service contract awarding and monitoring compares to best
practices. In order to meet the objectives, staff examined a random sample of
353 contracts and interviewed agency officials throughout the Executive Branch
of state government. Surveys were also sent to 2,199 contractors who have done
business with the state to get their input. Staff also reviewed professional
literature on contracting and contracting practices of other states.

Mr. Hewlett said the state accounting system identified
about $354 million in contract personnel expenditures for FY 2002. That account
does not include MOAs, Medicaid Managed Care for Region 6, contracts for
services incidental to purchasing items, such as copier installation and
service, or major construction projects, such as the new Transportation
building. Mr. Hewlett said expenditures for service contracts grew rapidly
through most of the 1990s, but has declined slightly in the two most recent
years. The $354 million spent on service contracts amounts to hiring 8,100
state employees at the average state employee compensation of $43,500 per year.
The amount is also equivalent to 18 percent of the total approved positions in
the Executive Branch. Mr. Hewlett said the study was unable to determine
precisely how many people are working on contract, due to the varied nature of
contracts.

The "miscellaneous" category has the largest
number of contract services, followed by architectural and engineering
services, consulting services, and professional computer services. The
Transportation Cabinet and the Health Services Cabinet have the most
expenditures for contracted services.

The greatest strength of the contracting system is the
integrity and professionalism of the agency contract managers. However, serious
systemic issues surround the state's system leading to confusion,
inconsistencies, and errors. The report highlights four major problems: (1) Key
aspects of the state's system for issuing contracts for services is not
formalized in statute, or regulation, and existing statutes and regulations are
often vague, or inconsistent; (2) The analysis and documentation of the need
for a service is often inadequate. The analysis should be done before a contract
is developed and should include an assessment on whether the service can be
performed in another area of state government, or by a state university; (3)
The advertising of contract opportunities is often not sufficient to ensure
full competition by the most vendors possible; and (4) There is inconsistent
and often inadequate monitoring of the work performed on contract, particularly
sole-source contracts.

The study also shows that many contracts were awarded
without thorough analysis and documentation of the need for the service, and
"boilerplate" language is often used that gives no real sense of the
need for a service. Vendors often receive notice of contracting opportunities
through word-of-mouth, rather than by any formal process. In order to maximize
competition and minimize costs, a more comprehensive effort to get the
information out about contracts is essential. Mr. Hewlett said approximately 17
percent of the contracts in the study sample were awarded without competition
as sole-source contracts, and contract monitoring was very inconsistent. The
Cabinet for Families and Children had the greatest use of sole-source
contracts, and in discussions with cabinet officials, a number of these
contracts were with retirees to meet some short-term staffing shortages that
the cabinet was facing. Since the study, the cabinet has stated that it has
revised its contract award policy and is generally following an RFP process in
the award of contracts.

Mr. Hewlett said the study determined that the state cannot
be sure that it is getting what it paid for without adequate monitoring. Staff
also found that agencies were not using the available accounting tools to
report on contractor performance. MARS has the capability for agencies to
record comments about the performance of contractors, but the tool has been
used sparingly. In addition, a contractor's past performance should be
considered when another contract is being considered. Mr. Hewlett said only 50
percent of the sample contractors reported that they had received feedback over
the course of the contract, and almost one-fourth reported that they had no
feedback, or any kind of evaluation during the course of the contract.

The report included recommendations to address both contract
award and contract monitoring issues. Contract award recommendations included
the following: 1) that the need for any service contract should be documented
and rigorously assessed; 2) contracts should include clear language describing
specific tasks to be completed; 3) each agency should report semiannually to
the Government Contracts Review Committee on the number of sole-source
contracts issued; 4) agencies issuing large numbers of sole-source contracts
should be examined; 5) routine renewal of sole-source contracts should be limited,
and no sole-source contract should be renewed more than two times before a new
RFP effort is required; 6) agencies should be required to publicize contracts
to a wider audience using multiple methods, including internet, industry
associations, and print media. Recommendations to improve the contract
monitoring aspect of the system included the following: 1) the Finance and
Administration Cabinet should develop policies and provide training on contract
monitoring; 2) agencies should formally monitor contractor performance to
ensure the state receives good value for its money; 3) contractor performance
must be evaluated against specifics of contracts, and unsatisfactory
performance must be documented; and finally 4) the Government Contract Review
Committee should consider requiring detailed explanations of monitoring on any
sole-source contract submitted, and agencies should have a contract monitoring
plan for each contract issued describing how they ensure that the contractor
fulfills the terms of the contract.

Senator Pendleton asked if the contractors who reported that
they were never evaluated held large contracts, or smaller contracts. Mr.
Hewlett said it varied across the board.

Representative Wayne asked if a team of attorneys hired to
represent a cabinet in a large lawsuit is an example of a sole-source contract.
Mr. Hewlett said that is one example of a sole-source contract.

Representative Wayne asked if the study includes information
on contracts awarded to people who have made campaign contributions to a
political party, or to a political candidate. Mr. Hewlett said the committee
did not request that information for the study.

Representative Wayne asked if the recommendations were
formulated as legislation for the 2002 General Assembly. Mr. Hewlett said
legislation was introduced in the Senate that included most of the
recommendations. The bill passed the Senate but did not pass the House.

Representative Barrows asked if the study includes
information on personal service contracts that are for a service that the
agency is required by statute to provide versus contracting for a service that
may be outside the agency's authority. Mr. Hewlett said the study did not
attempt to trace a contract back to the authority of each individual cabinet.

Representative Barrows said there are arguments that
privatizing is more efficient, but there are also arguments that contracting is
a way to get around the merit system. He asked if the study covered this issue.
Ms. Wilson said that when agency managers were asked why they needed a
contract, some agency managers said they contracted for a service because of
the merit system, the statutory hiring limitation, and the constitutional cap
on state salaries impeded their hiring flexibility.

Representative Barrows asked about the duration of a
personal service contract. Mr. Meeks said contracts have to end within a
biennium. Ms. Wilson said all personal service contracts with the state have a
30-day kick-out clause so that even though there might be a contract, the state
can back out upon 30 days notice.

Senator Seum said the number of personal service contracts
has grown substantially since 1993, and the number of state government
employees has also grown. He asked if this information is included in the
study. Ms. Wilson responded that it is not. Senator Seum asked if agencies are
hiring retired employees back under personal service contracts. Ms. Wilson said
hiring retirees back varies at the individual agency level. She said some
retirees might be hired back by taking another position and becoming a regular
employee again, and some have been rehired on a personal service contract. Mr.
Meeks said often a retiree is hired back on short-term to train the person who
replaced them.

Representative Lee said the Cabinet for Health Services and
the Cabinet for Families and Children show a large number of personal service
contracts. He asked if the percentages take into account contracts with local
health departments, comprehensive care centers, mental health regional agencies,
collection for child support, or Medicaid manage care. Ms. Wilson said the
study only looked at contracts with private individuals, or corporations.
Contracts with public entities are not included in the percentage of contracts
held.

Senator Leeper said the media has recently reported about an
agency, or corporation having an unsigned contract with an individual, or firm.
Mr. Meeks said the agency being referred to is the Kentucky Wood Products
Corporation. The Chair of the Government Contract Review Committee has
contacted the corporation and requested that they submit all of their previous
personal service contracts to the committee. Mr. Meeks said the corporation
believed that it was exempt from the jurisdiction of the Government Contract
Review Committee because it was a private corporation. In actuality, the
corporation is a quasi-governmental corporation and should have been filing
contracts with the committee.

Senator Leeper asked if the committee has contacted the firm
that held the contract with the Kentucky Wood Products Corporation asking if
they hold other contracts with the state. Mr. Meeks replied that they have.

Senator Kerr asked if other states are also seeing an
increase in personal service contracts. Mr. Hewlett said there is not good data
from other states on the number of sole-source contracts.

Senator Kerr said she recently experienced some
unwillingness by the Executive Branch to provide information that she had
requested. She asked if staff had difficulty getting information and if they
believe they are getting above-board information. Mr. Hewlett said agency
managers were very cooperative and helpful, but the system is cumbersome and
not set up so that data can be easily extracted from the data base. He said
each contract had to be dealt with separately by going out and talking to the
individual agencies.

Senator Kerr said the number of miscellaneous contracts is
disturbing. She added that when there is so much paperwork, all of that paper
means money that is needed to run this state.

Representative Cherry said he had read that Kentucky has a
low number of state personnel per capita in a comparison with other states. He
asked if this information is available. Ms. Wilson said she would provide the
information.

Representative Ford said he was recently approached by an
employee of a contractor who said his employer would not give him a raise
because the state would not allow it. He asked if the state places any
limitations on benefits for contract employees. Mr. Meeks said the state does
not place any limitations on benefits for employees, but the amount of a
contract for the length of the contract cannot be increased once it has been
signed.

Senator Stivers said the Kentucky Wood Products Corporation
had another signed contract with a firm whose purpose was to lobby other
government agencies for funds for their corporate use. He asked if there is any
defining language requiring agencies to document what service is being
provided, the need for the service, and that the service could not be provided
by another state agency, or a university. Ms. Wilson said a "Proof of
Necessity" form requires this information; however, the accounting system
does not provide the information in a reliable way.

Representative DeWeese said the study was very enlightening
and confirms many of his concerns. He said there are many contracts in the
human services area. He asked if the utilization review committee and the
payment company are excluded from the study. Mr. Hewlett said they were not
excluded.

Representative Barrows said one legislator may view a
consulting contract as wasteful, when another legislator may view a consulting
contract as necessary, because it is important to his, or her district. He said
more information is needed on the miscellaneous personal service contract
category in order to prepare for a budget. Ms. Wilson said Program Review staff
can only do studies that are authorized by the Program Review and
Investigations Committee. She said that information can only be obtained by pulling
each contract individually and reviewing it, which is probably not feasible at
this point in the budget cycle.

Senator Kelly said there is no question that some personal
service contracts are important, but the Program Review study indicates that
the system is not monitored adequately and there is poor control, which makes
it difficult to determine if there is abuse occurring. Just recently, the media
reported about the unwritten consulting contract held by a party campaign
fundraiser. In another example, an individual donated his own money to his
campaign fund to run in a contested primary. It was reported later that the
individual was awarded a personal service contract for that same amount.
Senator Kelly said there must be some level of review and monitoring so that
the public is assured that tax dollars are not being used for inappropriate
purposes.

Chairman Sanders next asked Secretary Dana Mayton, Revenue
Cabinet, to address the committee regarding the Illinois Tool Works, Inc. (ITW,
formerly USX) court case involves the corporation license tax. In December, the
Franklin Circuit Court ruled that KRS 136.071 is unconstitutional under the
Commerce Clause, ruling that a Kentucky domiciled corporation that held stock,
or securities in other corporations equal to, or greater than 50 percent of its
own assets, could deduct those investments from the corporation license tax.
ITW filed a class action suit on behalf itself and of other out-of-state
corporations who had been denied the benefit of this preferential calculation
merely because they were located out-of-state. The Franklin Circuit Court
agreed with this commerce clause claim, but instead of extending the benefit to
out-of-state corporations, the judge has recommended taking the preferential
treatment away from in-state corporations. The court ruled that it would be
effective for the 2003 tax year, although the case is not yet final and is
subject to appeal. Secretary Mayton said this is another domestic preference
case where the General Assembly has taken action to try and stimulate growth,
or to get businesses to locate in Kentucky, but when the benefits are denied to
out-of-state companies, or individuals, lawsuits are filed and it is declared
unconstitutional.

Secretary Mayton said no fiscal impact would be felt, absent
action taken by the General Assembly, until probably FY 2004, possibly even
2005, depending on how long the case takes. About $32 million in tax refunds
have been applied for, and there is approximately $14 million in interest. The state
will not have to pay the $14 million if the judge's ruling on interest stands.
In addition, the $32 million may be a lesser amount if the judge's ruling that
the two-year statute of limitations applies because some of those claims may
not have been filed timely within the two-year statute as opposed to four
years. Secretary Mayton said these amounts have been booked as contingencies
every year and they are accounted for in the judgements.

Secretary Mayton said there could be about $25 million in
new revenue if the court's decision is upheld. Another option under the statute
is to consolidate the license tax return with subsidiary corporations although
it is difficult to know what the revenue impact of eliminating that
consolidated filing might be. Secretary Mayton said this is based on the
assumption that all of these corporations continue to be corporations. If the
corporation converts to an LLC, it is exempt from the license tax altogether.

Chairman Sanders announced that time will not allow hearing
the Medicaid portion of the agenda.

Mary Lassiter, Acting State Budget Director, and Bill Hintze
and Beth Jurek, Deputy State Budget Directors, reported on finding and using
one-time money for the 2003 budget deliberations.

Ms. Lassiter said the official revenue estimate for FY 2003
has been revised down $75 million from the estimate made in December 2001 in
preparation for the 2002 budget. Another $33 million revenue adjustment in 2003
is revenue that was assumed in appropriations bills as a result of the 2002
session, resulting in a total revenue shortfall for the current year of $108
million. Ms. Lassiter said the $108 million shortfall assumes $15 million for
necessary governmental expenses to pay for possible natural catastrophes, and
$48 million for the Department of Education SEEK average daily attendance
shortfall. On the plus side, there is approximately $161 million of identified
one-time funds and $7 million added back that was for campaign financing, which
is no longer on the table. An additional $4 million is yet to be identified but
other branches of state government have been invited to contribute to realize a
zero balance for this current year.

Chairman Sanders said Kentucky has had to deal with forest
fires and flooding over the years. He asked how much of the governmental
expense fund has been spent this year. Mr. Hintze said $5.6 million has been
spent this fiscal year. He said $22 million of necessary government expenses
was spent last year chiefly involving natural disasters or legal action, but
not exclusively. Chairman Sanders asked how much of the $22 million was spent
on forest fires. Mr. Hintze said it was around $5 million, the highest in
history.

Senator Kelly asked why an additional $135 million in
Medicaid expenditures for 2004 has been added to the balance that was presented
last week. Ms. Lassiter said in November, there was a budget shortfall of $144
million in the current year, and $265 million in the second year. The $135
million is a below-the-line figure to show that if actions that are being taken
to get the Medicaid program within budget are not acceptable, then the total
shortfall for 2004 will be even greater.

Representative Wayne said there is a question about
unclaimed lottery winnings for the Affordable Housing Trust Fund going into the
General Fund revenue stream and possibly being counted twice. Terry Jones said
the December 2001 estimate included $3.3 million in General Fund revenue based
on an assumption that the law expired. The administration, however, realized
that it was to be spent for affordable housing and it was designated to go the
Affordable Housing Trust Fund, so it was not double counted.

Ms. Lassiter said the cabinet feels that the FY 2003 budget
will balance because of the revision of the consensus estimate and the
unanticipated one-time money occurrences. She said a balanced budget is good
news for school districts and for state agencies because half of the year is
over, and the ability to implement cuts and withstand those cuts in the current
year would be extremely difficult. However, FY 2004 continues to look very
bleak. There is a budget shortfall in the current year of $394 million for FY
2004, and that does not include the Department of Corrections and Medicaid,
which could add up to a shortfall in excess of $500 million.

Ms. Lassiter said the $161 million in one-time funds, which
is being used to help address the shortfall in 2003, comes from two major
categories - $107 million as a result of changes in timing and $54.4 million
because of excess unappropriated and unbudgeted funds. Changes in timing are
the result of fund transfers, reduced expenditures beyond what was expected and
planned for, and the treatment of the ending balance that was planned for in
the appropriations bills considered in the last regular session and special
session. The excess unappropriated and unbudgeted funds that have been
identified include excess carry-forward funds at the end of FY 2002, a
reevaluation of some off-budget accounts, and some areas where current year
receipts were in excess of what was expected and planned for a year ago when
the original recommendations were made on a budget.

Senator Kelly said the media recently reported that
Seven-Counties is laying off as many as 89 people and cutting services to 1,000
people because of budget cuts. He asked if the action taken by the Executive
Branch was prospective action since there is the probability that the budget
will now balance for 2003, or are actual cuts being implemented through the
Governor's Executive Order. Secretary Morgan said the action involving
Seven-Counties is not prospective. She said Seven-Counties is looking at an
expenditure shortfall this year because of a reduction in Medicare and a
decrease in third-party liability collections. In addition, because of some
restructuring of Kentucky's Early Intervention program, which has been running
at an expenditure shortfall for the last five years, revenues from that program
to Seven-Counties are also reduced.

Senator Kelly said he is concerned about action being taken
against Seven-Counties because of efforts to save money in the budget. He asked
if there will be additional reductions because of continued flat-line spending,
or because of across-the-board cuts. Secretary Morgan said across-the-board
cuts will not be made unless the Medicaid budget has to absorb a 2.6 percent
reduction in revenues.

Representative Damron asked how much money is being taken
out of the Kentucky Access program. Ms. Lassiter said the appropriations bills
that were considered in the regular and special sessions last year planned for
$36 million in fund transfers in FY 2003, and $13 million in FY 2004. Because
expenditures for that program were less than anticipated this year, an
additional $7 million has been added for FY 2003. Representative Damron asked
how the program can expect to remain solvent. Ms. Lassiter said there are
uncertainties for the future, including levels of enrollment and the impact of
health care costs. She said the cabinet has the ability to bring revenue into
that program through an assessment process. Representative Damron asked if
there is a possibility that the dollars coming out of Kentucky Access could be
recouped through an assessment on insurance premiums for associations and
businesses across the state. Ms. Lassiter said that is possible.

Representative Damron asked about tobacco settlement funds
being used to balance the budget. Mr. Hintze said in addition to the amount
considered in the session, there is $5.1 million in excess of budgeted FY 2002
payments, exclusive of the county portion. There is also an increase in the
revenue estimate of $1.4 million. Representative Damron asked if the $1.4
million is interest income from those funds. Mr. Hintze said there are a series
of investment income receipts not included in the funds deliberated by the 2002
sessions. From the respective funds, the total is about $1.2 million.
Representative Damron said some of the money did come from the investment of
the county's portion of the tobacco settle funds because the state did not meet
the deadline for grant requests so that money was still in the fund.

Senator McGaha said he introduced a bill in the 2002 session
that captured the farmer's share of the investment interest of the tobacco
settle funds so that it goes back to the farmer. The bill passed the Senate
unanimously, but it was not heard in the House.

Representative Callahan asked if the new one-time money that
is being used to balance the 2003 budget means there will not be more agency
program cuts. Ms. Lassiter said the carry-forward money has impacted agencies,
but the proposal is to balance the current year without the types of
across-the-board cuts that have been feared.

Senator Kelly said the carry-forward funds that are being
transferred from 2004 to 2003 may be solving the problem for 2003, but it
dramatically complicates 2004.

Representative McKee said House Bill 611 allowed 50 percent
of lapsed funds for agriculture, and 50 percent to some other programs He said
it is important that we do not leave this meeting thinking that some of the 50
percent for agriculture is in that unexpended money, because that is not right.
Ms. Lassiter said it is not in the unexpended money.

Ms. Lassiter said Governor Patton is very sensitive to
keeping the state on as firm a financial footing as possible and his rationale
is to keep moving forward in the key areas of education and other high profile
areas because the state cannot afford to make any more cuts. Counting 2004,
there have been four years of budget cuts and revenue shortfalls, and the
Executive Branch is operating basically flat-funded off of the reduced 2002
base. The Governor's proposal is to use as much one-time money as can be
identified in 2003 to balance in 2003, and then focus on 2004.

Senator Stivers asked how personal service contracts are
built into agency budgets. Mr. Hintze said agencies are appropriated operating
budget funds. Senator Stivers asked if each cabinet is responsible for knowing
how much of their budget they should apply towards personal service contracts.
Mr. Hintze said some agencies would know how much to budget for a personal
service contract, but it depends on the character of the contract and the
service provided.

Chairman Sanders asked if the revised revenue estimate guarantees
that the education budget will not have to be cut in 2003. Ms. Lassiter said
the Governor's proposal is not to cut education.

With no further business, the meeting was adjourned at 12:55
p.m.

All meeting materials and a tape of the full meeting is
available for review in the Legislative Research Commission library.